Just what is the "Market" anyway?Submitted by Cameron Woods Portfolio Management on May 4th, 2018
May 4th, 2018
By: David Cameron
In keeping with our belief that, as De Vinci is rumored to have said, simplicity is the ultimate sophistication let’s take a look at what the market is and is not.
The market is not a person or some kind of mindful being. It’s a human construct; an invention. We made it up. The stock market isn’t singular. The stock market is like any other market in as much that it’s just a bunch of people haggling over the price of something based on some rules that we also made up.
It does indeed feel like a unique entity at times, I’ll give you that. This is because we’ve also managed to invent a way to take all the millions of transactions and reduce them to single numbers. We call these Indexes. “The DOW was down 300 points today. The market doesn’t like the uncertainty of … “. You can fill in any reason you want here. It works as long as we, as a group, agree that it’s going to work. This is people and machines (programmed by people - at least for now) buying and selling stuff.
Why does someone buy a stock on the market? Again, in the spirit of simplicity, I think there’s really only one reason - because they expect to sell that stock for more than they paid for it at some point in the future. That’s it! I know some of you are going to start arguing with me immediately, but bear with me. Yes - the buyer will have a story or reason or rational behind the purchase that justifies the “Why I buy”. A reason like interest rate changes, the price of oil, a Trump Tweet, insider information or in our case probabilities. But the honest, simplest, reason is because you expect (or hope? - remember, not a strategy) to sell it for more than what you paid for it.
Why does someone sell a stock? Well, I could fill a 32MB zip drive with reasons why people sell (that’s a lot of reasons). Here are just a few. You die, you get divorced or your credit card is maxed out. You get scared, you want to buy something else like a new car or you need to pay for a pacemaker. Or, in our case, the odds change and you sell - obviously right!
So remember: One reason to buy. Many to sell.
This leads us to the next point. Some markets are made up of stocks. What makes a stock go up? Often you’ll hear “There are more buyers than sellers.” Ah, well, yes - sort of. If you happen to make this observation yourself there’s bound to be one hair splitting semantics junkie who’s going to retort: Actually (they always start every sentence with “actually” don't they?), there are exactly the same number of buyers and sellers. So, while this misses the point it is nonetheless true and worth taking a closer look at.
One buyer + One seller = One Transaction at a specific price.
When we say the price is going up because there are more buyers than sellers what we really mean is this:
There are more motivated buyers lining up who are willing to PAY the sellers asking price than there are sellers who are motivated to sell and therefore willing to accept the buyers offer.
Flip this around and the price starts going down: More buyers willing to accept the sellers offers to buy than buyers willing to accept the sellers asking price.
Returns are a behavioral phenomenon.
And there you have the law of supply and demand. Add it all up and you have a market playing tug of war between those who expect what they buy to go up and those who sell for innumerable reasons. If you’ve noticed that the reasons behind buying and selling seem a bit out of balance, one reason to buy and many to sell, you’re quite right. Stocks and the markets made up of them can start to go down not only because of a big increase in sellers but also because the buyers simply go away as the expectation of future gains diminished.
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